I think the short answer is: That depends!
Let's assume you have a super perfectly sharp point on your v-bit - in theory, your smallest size will mostly depend on how well your material holds up (do the insides of P or O or A stay together?) -- so it still depends ...
In MDF, with a 60 degree cutter, assuming it has a really good sharp point (not all of 'em do!) and can cut a fine line, then you could get pretty small ... 1/4" tall letters aren't out of the question. You may be able to push it smaller with some kind of pre-treatment to harden up the surface of the material (like wood hardener, CA or even a few coats of finish like poly or shellac soaked in).
To a lesser extent, your machine may influence this, too - if you have a little backlash, it can become more apparent when trying to make a line of small text because some slight variations might make the baseline a little wiggly.